Secrets to Preventing a Tax Audit at Your Medical Practice

Just mention the word "audit" to any physician audience, and you can almost see the collective shiver run down their spines. Their feelings of dread match those when encountering the word "sue!" Unfortunately, the Internal Revenue Service is stepping up their audit enforcement against doctors, based on their perception that doctors make easy targets due to poor record-keeping practices.

Most physicians in medical practice have received some training in reducing their malpractice risk, but little or nothing is taught about how to minimize the risk or impact of a tax audit on your psyche and your practice.

Tax Planning Can Reduce Audit Risks

Recently, many physicians have received letters from the IRS informing them that they are being audited. This notification is frequently accompanied by a laundry list of document requests that goes on for three pages. After overcoming the initial stage of panic, most physicians go to their CPA, who assists them in putting together the documentation requested.

Some potential audit issues can be avoided with more dialogue between the CPA and the physician during the initial return preparation stage. Many CPAs unfortunately take information from their doctor clients and put it on a tax return without enough "questioning." CPAs frequently complain that physicians do not make the time to meet and thoroughly discuss the material provided, or that the physician has dumped all their records on the CPA just before tax filing is due. "Being too busy" is sometimes just a disguised excuse for procrastination.

Red Flags for Tax Audits

One of the areas that the IRS is focusing on is deductions related to business travel for physicians. It is the belief of the IRS that doctors routinely over-deduct for education-related travel; staying at hotels that are beyond the level and price point of the hotel where a seminar is provided is just one example.

Another hot button item is the notorious lack of doctors’ record keeping, resulting in office expense estimating ("guesstimating" as the IRS would call it). A good business manager who works hand-in-hand with physicians can assist in this initial organization phase and nip that problem in the bud.

If an audit is not going well, the CPA will typically recommend bringing in a tax attorney to interface with the IRS. Tax attorneys litigate cases with the IRS in the United States Tax Court, and typically can obtain settlements with the IRS that may save the physician a tremendous amount of money. However, the authors are of the opinion that the entire audit can be avoided or handled very smoothly without any repercussions if the physician had taken some preliminary steps.

Nor is it only the IRS that can come knocking. One of the authors’ clients, a busy family physician with both a private practice and a large nursing home practice, was confronted several years ago with the prospect of a Medicare audit evaluating potential over-coding. This soul-destroying experience involved hundreds of hours of copying and submitting medical records, hiring both an attorney and a coding expert to help defend her case, and a lingering terror of coding too high, such that her resultant under-coding was costing her practice thousands of dollars. She was a good doctor, she was a good person, yet she was a disorganized, stretched-too-thin and ill-prepared business owner. Sound familiar?

IRS Examining Improper Medicare Payments

In 2010, President Obama set three goals for reducing improper Medicare payments, to be achieved by this year:

1. Reduce overall payment errors by $50 billion

2. Cut the Medicare fee-for-service error rate in half

3. Recover $2 billion in improper payments

To begin achieving these goals, CMS focused particularly on number three: improper payments. It's important to recognize that while all falsified claims are improper payments, not all improper payments are falsified claims. In fact, most are due to ignorance - errors in documentation and not intentional fraud.

Next week, we'll provide six steps to minimize the risk of a tax audits and malpractice suits at your medical practice.

Philippa Kennealy, MD MPH CPCC PCC, is president of The Entrepreneurial MD. She is a board-certified family physician who left her own private practice in 1996 to embark on an administrative career as first medical director and then CEO of UCLA-Santa Monica Medical Center. She now works as a business coach with physicians who are striving to be entrepreneurial or businesslike. She is a member of the American College of Physician Executives, the American Academy of Family Physicians, and the California Academy of Family Physicians. E-mail her here.

Philip Garrett Panitz, JD, LL.M (Taxation) is a certified tax specialist and has a doctorate of law and a Masters degree in taxation. He has successfully litigated hundreds of tax cases and represented physicians in cases with the IRS. He argued and won the case of Williams v. United States before the United States Supreme Court. E-mail him here.